High inflation just pushed IRS deductions and tax rates higher — here’s how much, and when they kick in

America’s high rate of inflation will result in a 7% increase in the standard deduction when workers file taxes on their 2023 income, according to new inflation adjustments from the Internal Revenue Service.

It will also increase tax brackets by 7%, according to annual inflation adjustments the IRS announced on Tuesday.

Many provisions of the tax code – but not all – are indexed to inflation, so the announcements are a recurring event. But when inflation persists at four-decade highs, these annual adjustments are of particular importance.

If inflation persists at four-decade highs, these annual adjustments of around 7% are of particular importance to the standard deduction.

Start with the standard deduction that most people use instead of listing deductions.

The standard deduction for individuals and married couples filing separately is $13,850 for tax year 2023. That’s an increase of $900 from the standard deduction of $12,950 for the upcoming tax season.

For married couples filing jointly, the payout for the 2023 tax year increases to $27,700. That’s an increase of $1,800 over the standard deduction of $25,900 for the upcoming tax year.

The increases in marginal tax rates reflect the same 7% increase. For example, the 22% tax bracket for this year is over $41,775 for singles and over $83,550 for married couples applying together. Next year, the same 22% bracket will apply to incomes over $44,725 and over $89,450 for married couples applying together.

MarketWatch/IRS

“The changes appear to be much larger than in previous years because inflation is much higher than in previous decades,” said Alex Durante, an economist at the Tax Foundation, a right-wing tax think tank.

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The IRS gets its inflation adjustments by averaging a slightly different measure of inflation called the “chained consumer price index,” instead of the widely watched consumer price index, Durante noted. That’s a result of the Trump-era tax cuts and jobs bill of 2017, he added.

“The reason is that the regular CPI overstates inflation because it doesn’t account for the substitution that buyers can make as costs rise,” Durante said. Shoppers substitute when exchanging a more expensive item for a cheaper one, and research shows many Americans use this tactic.

The IRS inflation adjustments come after September CPI data last week showed September’s annual inflation rate of 8.2%, slightly below August’s 8.3%. Also last week, the Social Security Administration said next year’s payments would include an 8.7% cost-of-living adjustment.

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The Earned Income Tax Credit payout – aimed at working low- and middle-income families who have been hit hard by blistering inflation – is also increasing.

The payout of the income tax credit also increases. The maximum payout for an eligible taxpayer with at least three eligible children increases to $7,430 for this tax year from $6,935. The long-term loan is aimed at low- and middle-income working families who have been hit hard by blistering inflation.

More than 60 provisions are scheduled to increase in line with inflation, but many parts of the tax code are not inflation-indexed. Depending on the circumstances, the tax or the tax concession take effect earlier.

Capital gains tax rules an example. The IRS lets a taxpayer use capital losses to offset capital gains taxes. If losses exceed gains, the IRS allows a taxpayer to deduct up to $3,000 in excess losses. You can then roll over the remainder of the capital losses to future tax years. According to Durante, it has been more than four decades since lawmakers last set the limit.

While more than 60 provisions provide for an inflation adjustment, many parts of the tax code are not inflation-indexed. They include capital gains tax.

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Given the stock market’s rocky slide this year, many investors could welcome a fast-approaching tax break — even if it only allows for a $3,000 deduction.

At the same time, a couple selling their home can exempt the first $500,000 of the sale from capital gains tax, and it’s $250,000 for a single applicant. This has been the case since the exclusion was introduced in 1997.

The once-white-hot housing market may be cooling, but many sellers may still be at the point where the taxes take effect. According to Redfin RDFN, the average home listing as of early October was over $367,000.
+4.05%.

Another example is the child tax credit. After last year’s payout to parents increased to $3,600 for children under 6 and $3,000 per child ages 6 to 17, it’s back to a maximum of $2,000. The refundable portion of the balance increases from $1,500 to $1,600 in the 2023 tax year, the IRS notes.

Proponents of the increased payouts and some congressional Democrats want to revive higher payments in corporate tax negotiations. The high cost of living is a strong reason to get the increased loan back, they say.

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